What to Do Once You're Out of Debt - Becoming a Net-Interest Earner

Debt is really a double-edged sword. On one hand, you're obviously inhibited by the monthly interest and principal payments that you have to pay in order to stay current on your debt. This burden prevents you from spending your hard-earned money on things you'd rather buy - from the frivolous (DVDs, designer jeans, movie tickets) to the more serious (higher quality food, new furniture, tuition). But more seriously, debt prevents you from getting ahead in life. After all, after paying your debts and other bills, whatever is left over has to go towards things other than investments or retirement savings.

Not only do monthly debt servicing payments prevent you from investing for your future, the high interest rates attached to most debts actually make saving and investing bad ideas. After all, if you're paying 18% credit card debt or 530% payday loans, it doesn't make much sense to buy a 5%-yielding CD or a stock that is likely to earn 10% if you're lucky. Any and all extra money that you have should go towards paying off your debts, but unless you have uncanny discipline, it is much easier to pay the minimums and spend your extra cash on things you don't really need. After all, saving is pointless when you're in debt, right?

Why It's So Important to Get Out of Debt

The strange truth is, yes, it is silly to save or invest money while you're paying 10%+ in interest. Even the world's greatest investors shoot for 10% or 11% yields, so how can you expect to come out ahead by investing while you have debts with much higher interest rates? The only way to get ahead is to get out of debt and then reverse the situation: Instead of being a net-interest payer, be a net-interest earner!

Have you ever considered exactly who you're paying your interest payments to? Ultimately, you're not paying some faceless corporation, but individuals just like yourself. You're paying people who own shares of stock in the bank, who in turn are paying individual depositors interest for the funds necessary to make your loans. You're paying the sole proprietor of a payday-loan shop, or the individual investors who have purchased your home loan as part of a mortgage-backed security. Every cent of interest you are paying each month is eventually going to another person - it doesn't just evaporate. So what do you need to do to become one of these people?

Know the Difference Between Good and Bad Debt

Yes, some debt can be good. If, for example, you inherit $10,000, should you necessarily pay off your student loans? What if the interest rate on your loan is just 6.5%? Wouldn't it potentially be wiser to save or invest the money? Just blowing it at the mall probably wouldn't be a good idea, but what if you need a new used car? It wouldn't make much sense to pay off your 6.5% interest student loans and then borrow $10,000 to buy a new used car at 10% interest, would it? Of course not. Net-interest earners are not necessarily debt free; it's just that they earn more in interest or other investment income than they pay in interest. One way to do this is to pay off your high interest loans and leave your low interest ones on your personal balance sheet so that you can use your money to gain a higher percentage return than you're paying in interest.

Another typically low interest loan is your home mortgage. Many people advise homebuyers to make one extra mortgage payment a year so that the 13th payment will be applied directly to their home loan's principal, thus paying it off much earlier. But if you have a 5-7% mortgage, it would often be a lot smarter to take that extra money and invest it in a mutual fund. If you can hope for a 9-11% return, you will be a net-interest earner.

A Change of Heart and Mind

Once people find themselves deeply in debt, they often have only one goal - getting out. Once they're out, they think that they'll finally be free, but the reality is that true financial freedom comes from being a net-interest earner, not from merely being debt free. After all, working until you're 67 and hoping to live off Social Security is not a wise strategy. You need to begin developing streams of passive income as soon as you can, and you will never be able to do so if you resolve to forsake the credit and banking industry once and for all as soon as you're out of debt. Credit is a wonderful thing for borrowers when used responsibly, but more than anything, you need to make the transition from net-borrower to net-lender. This is how modest fortunes are made.

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